Is trust the new currency?

Looking back to the global financial crisis, one of the features of that period was the lack of trust in - and within - the big financial services players.

There has been a massive regulatory and political response to the damage to financial stability and global economic health caused by that crisis.

That response and the focus on financial stability masked, at least initially, the risks caused by poor conduct.

Right now, in a very visible and painful way, the failure of management and boards to understand how to have their employees - and the products they sell - generate fair outcomes for their customers is costing them dear.

Across the Tasman, the issues and behaviour highlighted at the Australian Royal Commission have been truly extraordinary. The importance of good conduct could not have been more clearly underlined. Broader concepts such as community standards and the so-called social licence of big financial institutions are also in play.

Like other stakeholders on both sides of the Tasman, at the FMA we are still processing these ongoing developments and examining their relevance to NZ.

However, we are determined to play our part in ensuring that this unique opportunity to ask the industry and ourselves hard questions is not lost. We hope that this firestorm will result in customer-centric conduct being permanently embedded within the culture of the financial sector. But we know it won’t happen overnight.

So you could say that this is the second phase of a crisis in trust for financial services.

Edelman Trust Barometer – 2018 report showed:

As a general proposition:

An increasing sense within the general population that the top slice of society (in terms of wealth) have access to information and opportunity that the rest of us don’t

There is an increasing distrust of major institutions (both public and private) and far more influence of peer-to-peer mechanisms. Think of what Air BnB, TripAdvisor and Trivago have done to the hotel industry.

The report showed that the slow recovery in trust of financial services businesses since 2012 has stalled. In major jurisdictions such as the US, Hong Kong, Brazil and France that trust has dropped since 2017 by double-digit percentages – as much as 20% in the US.

The report reflected on the fact that we trust our banks to complete transactions on our behalf (mostly) and to keep our assets safe from fraud or cyber-theft, but that we don’t trust them to look after us.

So trust is on the decline again. It’s a currency that, in some quarters at least, appeared to have lost its value

So how did we get here?

If you look at some of the financial services ‘supermarkets’ that banking groups have become, you can make the argument that banks are spread too thin across product lines – synergies and cross-selling never happened naturally and forcing them has led to bad outcomes.

Shareholder expectations emphasising short-term earnings over long-term value drove boards and management beyond the bounds of what was decent and right.

The focus on serving shareholders above all else, in much of the current Western corporate law model, might be argued to be at the heart of the issue.

You can debate whether the current model is too heavily focused on returns for shareholders or returns for management.

It certainly doesn’t look like it’s too heavily focused on returns for customers.

I note that Wayne Byers at APRA (the Australian Prudential Regulation Authority) has been commenting along these lines for the banks – looking for clearer lines of management responsibility and the consequences that should go with it for failures in their areas of responsibility

He specifically commented there was too much emphasis at board level on shareholder returns – albeit that’s a hard criticism to levy against the shareholders who appoint the boards.

How do we change this?

Some of this can be achieved by regulation, but not much.

The Financial Markets Conduct Act actually doesn’t talk much about fair treatment or community expectations. It does set out a bunch of things that the issuers or sellers of financial products ought to do.

We all like to feel we are special and in this context I think it is arguable that financial services poses some particular challenges.

The information asymmetry between providers and consumers

The difficulty in knowing, at the point of sale, whether a product is suitable

The fact that any harm caused by poor product design or inappropriate sales or advice often manifests only years later – if at all

Some of the decisions required by consumers can be life-changing and providers need to respect that.

The FMA has pushed licensed firms to ask themselves some hard questions:

- Not just “do we comply with the law?” but “Is this the right thing to do?”

- FMA Conduct Guide (published February 2017) was resisted in places for seeking to extend the law past the actual legislation, or to place “demands” on licensed firms that are unreasonable or overly prescriptive.

Well – if you want the sector to be trusted, asking what’s right, rather than what’s not against the law – that is what’s necessary

How can financial services firms differentiate themselves in the conduct space?

The Edelman report talked about some pluses and minuses in terms of what can drive customer trust:

On the plus side – top 3:

easily understood Ts&Cs

reliable fraud protection

easily accessible information on products and services.

On the negative side – top 3:

poor product or cost transparency

confusing descriptions of products and services

unwanted selling pressure.

Charging people, alive or dead, for services they never received or were even aware might be available to them, ought possibly to make the list of negatives.

So one challenge here is how to re-engineer these complicated institutions so that the voice of the customer is heard – and where the customer has no voice, because they don’t actually know themselves what good looks like, someone else is looking out for them.

For boards:

Change your view of how much money senior management should make.

And how much shareholders can expect…

And focus unrelentingly on serving your customers.

And, in this context, the customer is of course the end user of the product, not the intermediary who is selling it for you.

For boards and management:

I can’t stress enough that we can’t change this by tinkering at the edges. Change has to be more fundamental.

The Sedgwick report in Australia did a good job of calling out the conflicts and poorly aligned motivations caused by paying for sales.

Unfortunately, it didn’t foresee the drama of the Australian Royal Commission and the tipping point that public exercise is creating in terms of public trust in major financial service providers.

So the recommendations about balanced scorecards and the like, which still retain elements of sales volumes – just didn’t go far enough.

It will hurt sales for sure, and it will hurt shareholder returns too – in the short-term – but we are finally seeing firms begin to move away from paying their staff for sales.

We are finally seeing firms question their use of soft commissions to incentivise advisers from “advising” customers into their life insurance policies.

But again, how are these fundamental changes going to happen?

Many of you will have heard me say it before and we were clear on it in our Conduct Guide:

There’s no point pontificating at the top about treating customers well unless you build the systems, the controls and the culture that does it for you.

Even the best management team has little chance of being everywhere at once and in every decision.

As the moral academics will tell you – it’s the instinctive decisions your staff make when no one is watching that define your firm’s “moral sense”.

Its why in our work with the Reserve Bank NZ, in looking at Conduct & Culture, we have spent less time trying to unearth isolated but dramatic failings to publicly humiliate banks or insurers with.

But we have focused more on whether the fair treatment of customers is actually embedded in how these firms are set up:

What are the criteria for paying or promoting people?

What are the fundamental design principles for new products?

How are complaints handled? What do you do where even though the facts were short of a breach of the law, nonetheless there is a disappointed and confused customer?

How did you build the processes or training so that customers understand the limitations of the product sold to them or the risks inherent in the investment you recommended?

What’s in place to make sure customers understand that the employee is only advising on, or offering products from their own employer?

Are sales staff trained to listen for the questions that aren’t asked – to identify customers who might need more help to make a good decision?

In the Conduct & Culture review, we and the RBNZ are making assessments across four broad themes:

Governance

Conduct risk management

Customer focus

Remediation

This is designed to get under the skin of how these organisations are operating – so not only looking at intent but looking at how it is actually working in practice.

And here’s the challenge – this may all be dull to you because you know it already.

You don’t need me up here banging on to know this is true.

But the public don’t believe you know it. Or if you do, that you are really going to change it.

I see how hard many of you and your firms are trying to shift the way you operate to earn my trust and that of your customers.

But I really don’t think they [the public] see it. The issues highlighted by the Australian Royal Commission have probably set this back a good bit, even on this side of the Tasman, but in any event change was moving slower than it needed to.In terms of an understanding of the need to build the right structures and processes, we see variances across firms in each sector and even within firms.

Some of the firms that strike us as having a genuinely client-focused culture in some parts, don’t in others. Even those that do aren’t always creating and embedding the repeatable processes and requirements internally to ensure it happens every time.

You can’t “will” good conduct on a financial services firm above a certain size. You have to wire it in.

That sounds dull, and it is.

But without it, inevitably things will not be as good as they need to be for consumers and investors to genuinely believe that they will get a fair deal.

I should also add that we at the FMA are conscious that for any regulatory system to work well there needs to be trust in the regulator.

That’s trust that the regulator will behave fairly and proportionately.

And trust that they will be effective.

It’s why one of our strategic priorities in our Strategic Risk Outlook and Annual Corporate Plan is our own efficiency and effectiveness. We need to spend the money we gather in levies and fees, and that we receive from the taxpayer, to do the best job possible of regulating the pieces of financial services that we licence and that we oversee.

We are still learning on the job and we appreciate that the industry is too. We have however signalled that while we are proud of the efforts we have made to engage with and set out our expectations for the industry, we are also frustrated in places with the slow pace of change. That frustration will manifest itself over time as we become less understanding and less tolerant of firms that talk a good game but don’t put the hard yards in to make sure it happens.

I will finish by saying that these days, I suspect the real crooks don’t go into regulated financial services.

There are too many rules and there’s too much risk of getting caught.

They set up on the edges and they try to operate out of the sight of the referees.

But what seems to happen in financial services is an insidious slide into “it feels a bit tacky but everyone else is doing it and we can’t afford to be left behind”.

Changing profitable practices and behaviours that seemed fine only a few years ago because the expectations of customers and regulators have changed seems hard.

Well, have some faith in the long-term power of trust and the differentiator that trust and fairness will be. You know it makes sense.

NOTE FOR READERS: These are speaking notes. The speech delivered may differ slightly from these notes.